There are a variety of techniques for valuing life insurance for sale purposes. The appropriateness of each technique depends on the type of sale being contemplated.
- Sale to an unrelated third party – the value should generally be whatever the parties agree it is. That is the very essence of fair market value (assuming a willing buyer and willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts).
- Sale to a related third party (e.g., the insured’s child) – if the IRS determines that the sale price is not adequate, then it could be determined to be a part gift/part sale, and gift issues may arise. In this situation the safest course of action is to use the ITR value as the purchase price.
- Sale from an employer to an employee (or a qualified plan to a plan participant, or to a trust on behalf of the plan participant) – Revenue Procedure 2005-25 should be determinative of the minimum value needed to avoid adverse income tax consequences (i.e., greater of ITR or PERC should be used as the value).
- Sale by a trustee – Sometimes an insured has created an Irrevocable Life Insurance Trust (ILIT), the terms of which are no longer satisfactory. In this situation a common strategy is for the insured to create a new ILIT with more acceptable terms and have the trustee of the old ILIT sell the life insurance policy owned by it to the new ILIT. Since the insured has to seed the new ILIT with a gift, the insured quite likely wants to keep the purchase price as low as possible.
In this case the goals of the old ILIT trustee may conflict with the goals of the insured. The trustee owes a fiduciary duty to the beneficiaries of the trust, and pursuant to such duty should seek to sell the policy for its fair market value. To do otherwise could constitute a breach of fiduciary duty. The question here is, “What constitutes its fair market value?” Can the trustee sell the policy for its cash surrender value? What about for its ITR value? Does the trustee have an obligation to see if there is a secondary market for the policy, and if so, use that value?
There are no clear answers here. The value used will likely depend upon the specific facts involved. Just be aware of the potential conflict that exists and the fact that the trustee has some potential fiduciary liability issues. If the risks of a valuation dispute are great, such as where the new ILIT is being established to exclude a beneficiary of the old ILIT, you may want to suggest that your client use the most conservative value available (which may involve seeing if there is a secondary market value). A sign-off by adult beneficiaries of the selling trust might also be considered.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM